As of April 15, India’s foreign exchange reserves have shrunk to $603.7 billion from $631.5 billion at the end of February. From February to present, foreign institutional investors have sold stocks and bonds worth 98,988 crore. The money has to be converted into dollars to take it out of India. This drives up the demand for the dollar and as a result, the rupee loses its value.

A weaker rupee makes imports expensive, especially crude oil, a product that India imports about 85% of its needs. Higher prices for petroleum products can push inflation even higher. Therefore, to control this, the Reserve Bank of India (RBI) sells dollars and buys rupees, ensuring that enough dollars are circulating and that the rupee does not lose value quickly. RBI’s foreign exchange reserves dwindle in the process.

Show full picture

Eclipse

Note that the demand for dollars also comes from a booming import bill. In FY22, total merchandise imports increased 55% to $612 billion from the previous fiscal year. Imports of goods increased mainly due to the surge in commodity prices over the past six months. The total oil import bill in FY22 nearly doubled to $161 billion. By comparison, the amount of oil imported in the 11 months to February 2022 was 256 million tonnes, just 9.4% more than in FY21. The same story also plays out for coal. While the total coal import bill doubled, the quantity imported decreased by 5%.

Imports require payments largely in dollars. Therefore, as imports increase and the demand for dollars increases, the supply of dollars must also increase. However, exports of goods in FY22 rose 44% to $420 billion from a year earlier, which is clearly not enough to fund the surge in imports.

Also, things have not gone well with the net inflow of foreign investment, which brings in dollars in India. It is the sum of net foreign direct investment (FDI) and net portfolio investment (NPI). Net FDI is obtained by subtracting India’s outward FDI from foreigners’ FDI in India. The net NPI is left after subtracting the investment made by Indians in stocks and bonds abroad from the investment made by foreigners in stocks and bonds in India.

In the 11 months to February 2022, the net inflow of foreign investment stood at around $25 billion, down sharply from the $80 billion seen a year ago. Simply put, although there has been a demand for dollars, the supply has not kept pace.

Now, while the drop in foreign exchange reserves doesn’t sound like much in absolute terms, the drop in import cover tells us the real story. At the start of 2021, he was over 18 months away. By April 1, it had fallen to 12 months. Import cover is basically the number of months of imports of goods that a country’s foreign exchange reserves can fund at any given time. So, although the fall was quick, we are still in safe territory. In fact, import coverage lasted around 10 months for much of 2019 and only started to increase in 2020 when imports crashed due to the pandemic.

Finally, it should be remembered that as long as the war in Ukraine continues, commodity prices will remain high, driving up the import bill. Moreover, with central banks in rich countries raising interest rates to control high inflation, foreign money invested in stocks and bonds will continue to flow out of India. This will keep demand for dollars firm and put pressure on foreign exchange reserves.

Therefore, RBI may have to let the rupee gradually depreciate instead of defending it at all costs. Of course, as the rupee is allowed to depreciate, some imported inflation is likely to creep in. This will force the RBI to raise interest rates. All told, it would be a tightrope walk for the RBI this year.

To subscribe to Mint Bulletins

* Enter a valid email

* Thank you for subscribing to our newsletter.

About The Author

Related Posts